Friday, May 24, 2013

Ideas Challenging the Invisible Hand

I've got a couple of concepts rambling around in my head that are challenging my economics world view.  I've been wrestling with one of these challengers for a while; the other is relatively new.  Readers of my blog know the Unrepentant Capitalist is a disciple of the Adam Smith, David Ricardo, and Milton Friedman school of laissez faire, free market economics, but these two challengers are in conflict with the core tenets of conservative economics—limited government and the profit motive.

Limited Government (Less is More)

The Smith, Ricardo, and Friedman school says the government's role in economic affairs should be kept to a minimum.  Ask any of these economists, and they'd tell you the government can serve the economy and society best by setting the rules (the fewer the better) and then enforcing them fairly.  Government ownership of businesses or crafting policies to favor particular industries are counterproductive and cause an economy to undershoot its potential.  They would argue the Department of Commerce is entirely unnecessary, and would question the wisdom of the government operated central bank (the Federal Reserve).

While I buy the limited government argument, I also have difficulty explaining away the long term benefits that our economy has realized from many years of government spending on technology.  Starting in World War II, and continuing to current day, the Pentagon has been a major buyer of technology.  Government fueled demand for jet airplanes, satellites, nuclear power systems, and all the electronic components inside this stuff greatly advanced the state of the art. Does anyone really believe that our commercial aircraft industry, for example, would be where it is today without years of DoD spending on military aircraft?  

The physicists and engineers would have invented the transistor and the integrated circuit, but didn't Pentagon requirements (backed by lots of procurement dollars) to make electronic gear process faster, weigh less, run cooler, and use less power push these innovations to occur sooner than they would have if driven by consumer demand alone?  With the invention of the integrated circuit, and the demand for better performance from various military and NASA programs, the microprocessor was born.  Would we have been able to establish our leading position in our various Information Technology industries as early as we did without the microprocessor coming along when it did?  In short, haven't many things powering our modern economy—software, mobile phones, the Internet, flying coast to coast in 6 hours—enjoyed a healthy tailwind courtesy of DoD spending?  How many companies have been born, and how many high paying job have been created over the years to help commercialize all the Intellectual Property originally created by defense spending?

I can hear Milton Friedman's rebuttal.  Do the economic benefits justify the trillions of public money spent on all this stuff?  I don't know how to do the business case on that one, but didn't the Cold War force us to spend that money?  Wouldn't have consumer demand eventually driven development of these technologies? Hard to say, but in the absence of government demand, would we have had these technologies as early as we did?  Imagine a 2013 where we're playing pong, talking on Gordon Gekko mobile phones, and marveling over the 'state of the art' 747.

The positive effects of government spending on our various technology industries, and the benefits to the larger economy has been a difficult question for the Libertarian leaning Unrepentant Capitalist to come to terms with.  While I wrestle with this question, some things are more clear.  I'm sure the Pentagon is inefficient in how they spend vs. private companies.  I'm deeply skeptical of government crafted trade policies seeking to protect certain industries (the track record here is very bad) or outright state investment in companies (Solyndra).

Profit Motive (Driving Proper Economic Decisions)

In his 2009 book Drive, author Daniel Pink presents some compelling arguments that question the power of the profit motive as an effective driver of economic behavior.

The profit motive says the goal of business is to turn a profit. The profit motive is a beneficial guiding force in that it ensures resources are being allocated to their highest and best use. If something is worth doing, there's a profit to be made.  If there's no profit, the market is telling you the resources used to create that something are being misallocated.  The profit motive works for the individual too. People will be drawn to vocations where they can make good money.  People will create great stuff if you dangle enough money in front of them.

Pink's book says the profit motive alone may not work as a motivator, and in some cases, may be counterproductive in a modern economy.  Pink suggests that up until recent times, profit and money as motivators work reasonably well.  But, as we evolve towards an economy with a heavier reliance on knowledge workers where we need more innovation and creativity from our workforce, money alone isn’t enough.  The author says that once a worker hits a market level of compensation (or as the author says, "with the question of money off the table") more money's effectiveness as a motivator starts to wane.  Bonuses don't work as we'd expect.  Once the foundational compensation has been met, the source of motivation shifts to softer things like worker autonomy, skill mastery, and work with a higher purpose.  

Pink cites numerous examples from our new economy to support his assertion that money is not the ultimate motivator.  To make his case, he presents an interesting hypothetical. Suppose you go back to the mid-90’s and ask people to predict the eventual market share winner among products from two competing organizations.  One product is from a well-known company with many commercial successes. This company has assembled a well-compensated team led by capable managers.  The other team is loose-knit band of unpaid volunteers with no formal management team and plan to charge nothing for use of their product. Traditional economics tells us the former group will be the heavy favorite to win. But once we pull back the curtain to reveal the products in question, we know Wikipedia won this battle, and Microsoft pulled the plug on Encarta years ago.  The tech world has other similar examples of great free stuff developed by unpaid workers including the Firefox browser and the Linux operating system.

Drive makes a lot of good arguments about teams and individuals achieving higher levels of creativity and productivity with autonomy, mastery, and purpose deliberately added to the workforce equation.  But didn’t we already know this?  To consider profit as the sole source of motivation seems very simplistic.  The new information here is the diminishing returns of more dollars as a motivator.  So if we all agree the soft components are also a requirement, how do we evaluate a company on these criteria?  How do we measure a company to know that it’s offering its workforce opportunities for autonomy, mastery, and purpose?  How do we know the company’s motivated workforce is creating value?  Old fashioned as it may be, profit (or loss) is an objective indicator telling us that something is (or is not) worth doing. Profit can be measured.  Given my left brain orientation, I need some real numbers.  Pink is on to something here, but I need some instrumentation to properly pilot the ship. 

While it might appear the Unrepentant Capitalist has taken a small step in the direction of Europe, I continue to fundamentally believe that free market capitalism is the best driving force to organize our economy—less government is better than more government, businesses exist to make a profit, brush and floss twice a day.  Having said all that, I also believe that strict adherence to one school or the other without taking time to consider the other side’s argument is not wise.  At the risk of edging up to the slippery slope, I believe the best answers can sometimes be found somewhere between strict ideological poles. The Unrepentant Capitalist continues to operate close to the Libertarian camp, but I’m not in the elder’s tent.

Invisible Hand – a phrase coined by Adam Smith in The Theory of Moral Sentiments (1759).   Smith tended to be a bit wordy (who wasn’t in the 1700's?) but, in essence, he said the economy is guided by an Invisible Hand that is the collective result of individuals pursuing their own economic self-interests in a free marketplace.  The Invisible Hand determines the goods and services available, the prices consumers will pay, the compensation tor those involved in bringing those goods and services to the marketplace, etc, etc, and does all this to society’s benefit.  

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